I’ve been convinced that Rolls-Royce (LSE: RR) shares would eventually recover. The big questions have always been how long might it take, and how low might the share price fall first? So is it a good time for investors to buy now? Here are three things I think could contribute to the turning point.
Shares up
Rolls’ shares are down 27% over the past 12 months. But since a low in mid-October, the price has climbed 34%.
The price alone is never a good reason to buy a stock. And I pay little attention to share price charts. But over the past couple of years, I’ve been seeing Rolls-Royce more and more as undervalued.
I think investors are very cautious, with the share price driven largely by sentiment. Some day, hopefully, sentiment will swing positive and remain that way. Has it already happened? I really have no idea.
But one of the things I look for in a recovery stock is an indication that the recovery is already under way. It might take a while yet for me to decide if it’s really happening. It’s definitely one factor in my buying decisions though.
Hydrogen engine
Rolls-Royce, in partnership with easyJet, has been testing a jet engine fuelled by hydrogen. It’s not some new clever engine design, it’s a conventional AE-2100A gas turbine, which is already widely used.
The industry contributes a relatively small proportion of the world’s carbon emissions. But it’s all released high in the atmosphere, and combined with other effects, the warming effect is boosted. Hydrogen, of course, contains no carbon.
I don’t think this test alone is a good reason to buy Rolls-Royce shares. It will surely be a good while yet before there’s any commercial value. My real point is that I’d only invest in Rolls-Royce for the long term.
These latest developments show that Rolls is focused on the long term too, and they give me some idea of where things might be headed.
Cash flow
None of this will do any good if we don’t get back to profit and to positive cash flow. The company’s November trading update paints an upbeat picture.
Rolls completed its disposals programme in September. And it’s already repaid its £2bn UK Export Finance-backed loan, which wasn’t due until 2025.
There’s £2bn in cash, with plenty of other liquidity. So I’d say the debt crisis is easing significantly. The board is sticking to its 2022 guidance, which suggests “modestly positive free cash flow” for the year.
Considering how close we are to the end of 2022, I think the risk of not hitting that target must be minimal now.
Risk
There’s still plenty of risk, mind. Global recession is not what we need to get people flying again, for one thing.
I’m also concerned about the stock’s valuation. When we get back to profits, how will the shares look on conventional valuation metrics? That’s just one of the big unknowns that investors face.
But I might find room in my portfolio for some Rolls-Royce shares in 2023.
